Something different in the food retail space
MoneyWeb - May 11th 2011, 12:22
Orapa – Of the three major food retailers listed on the JSE, Spar is the smallest. For this reason it is sometimes overlooked by investors.
The group does, however, offer something compellingly different from its larger peers. Spar acts primarily as a wholesaler and distributor of goods and services to the independent stores that operate under its brand, rather than as a corporate retailer. (It does currently manage a handful of stores itself, but this is likely to be a temporary measure.)
“Spar differs from other food retailers in that it's virtually 100% franchise,” says Coronation Portfolio Manager Quinton Ivan. “As the owner-mangers or entrepreneurs that run these stores earn their livelihoods from them, they are actively involved at all levels and need every store to do well. The result is that they tend to be more efficiently run than corporate stores.”
Spar's brands also include Tops, which has become South Africa's largest liquor chain, and hardware retailer Build it. Its operations cover seven Southern African countries – South Africa, Botswana, Namibia, Zambia, Swaziland, Mozambique and Zimbabwe.
Adriaan van Well created the Spar organisation in the Netherlands in 1932. His aim was to unite independent wholesalers and retailers to counter the growing power of grocery chains.
The Spar concept was launched in South African in 1963, when a group of eight wholesalers was given the rights to the name. At the time, they serviced 500 small retailers.
The group has since grown to operate six distribution centres and service over 800 stores across Southern Africa.
Spar has offered good dividend growth in recent years. The total dividend (interim plus annual dividend) paid for the year ended 30 September 2010 was R3.62 per share. This was up from R3.22 per share in 2009, R2.55 per share in 2008 and R1.85 per share in 2007.
The counter offers a dividend yield in the region of 4%.
Which funds hold this stock?
Three of South Africa's five best-performing general equity unit trusts over the last three to five years have a position on Spar. It is a top five holding in the Absa Select Equity Fund at 4.2%, while the Prudential Equity Fund assigns it a weighting of 2% and the Coronation Equity Fund 1.6%.
The stock also appears in the portfolios of two of the three leading industrial equity funds. It makes up 2.4% of the Coronation Industrial Fund and 2.5% of the Old Mutual Industrial Fund.
The more defensive targeted absolute and real return funds also favour the counter, with three of the top five including it in their portfolios. Spar enjoys weightings of 2.5% in the 36One Target Return Fund and 2% in the Coronation SA capital Plus Fund, while the Cadiz Inflation Plus Fund holds 0.9% of its funds in the stock.
To see which funds are buying and selling the counter, visit Moneyweb's Unit Trust Portfolio Tool.
Why would an individual consider investing in this company?
All food retailers offer a trifecta of benefits to any investor. Firstly, they provide a defensive position against economic cycles, as people need to eat, no matter the state of the economy. Food retailers also act a hedge against food inflation, as they can quickly pass on increased costs to the consumer and thereby protect their earnings. They are also highly cash generative businesses.
Spar's business model adds a fourth factor to this equation. By going the franchise route, the group is able to keep its capital costs to a minimum.
“We like franchise models because we like the fact that owner-managers run the businesses and its capital-light for the parent company running the backbone, which is generally quite a fixed-cost business,” Coronation's Ivan explains. “This means Spar benefits from the scale without making the capital investments.”
Spar's compelling offering to franchisees is that they provide a strong brand and the benefits of centralised buying power that enable individual store owners to compete with the larger retailers. Even though franchisees are not forced to buy from Spar, the company still enjoys a loyalty ratio of 80%. The low churn in franchises is another indication of the level of support the group enjoys.
What risks does this company face?
Spar's franchise model does have a downside in that the group is exposed to the profitability of franchisees in a number of respects. A number of Spar franchises struggled during the economic downturn and, faced with the prospect of losing some priority sites, Spar bought a handful of these stores during the course of last year. This was a move that runs counter to its established business model.
“There is a massive land grab going on in the food retail space,” Ivan explains. “Massmart in particular is looking to buy up sites, so if a franchise goes under, Spar has two options – either try to find another franchisee to fill the space, or step in themselves.”
The group has also had to deal with bad debts due to stores becoming unprofitable and franchisees being unable to meet their obligations.
In addition, the combination of low food inflation and pressure on consumer spending have impacted on Spar's earnings. When food inflation is low, retailers are faced with lower margins and therefore need to sell higher volumes to grow revenues. However, reduced consumer spending has made this difficult.
Furthermore, the group has had to deal with significant input cost inflation that has nothing to do with food prices.
“Spar continues to face increasing costs, particularly electricity for refrigeration, diesel prices and labour,” Ivan adds. “So although food inflation may be benign at present due to the strong rand, cost inflation is still there. In this environment, Spar needs to manage their own profitability while still supporting franchisees who are also struggling.”
Where does this company’s growth potential lie?
Many analysts believe that food inflation is likely to start climbing in the short term. Globally, food prices have increased noticeably in dollar terms, but this has been masked in South Africa by the strong rand. However, an expected depreciation of the local currency together with ongoing food shortages should see South Africa's food inflation start heading north.
“Spar will be major beneficiaries of that,” Ivan believes. “Through their pricing power they will be able to grow earnings. However, I still think this year is going to be a tough one.”
The group is also exploring the potential of including pharmacies at some of its stores in a move that mirrors Shoprite and Pick n Pay. While the dispensaries themselves are likely to be marginal businesses, the extra customers pharmacies attract and keep is what has made this approach profitable for other retailers. The first few Pharmacy at Spar dispensaries have already been opened.
As Spar CEO Wayne Hook told Moneyweb last year, the group believes that these pharmacies will complement their existing businesses.
“You obviously want to have a complete offering, so we have food, we have liquor. In the emerging market we also have the hardware chain, and we believe that pharmacies are an important, let's call it, convenience, that fits our total offering.”
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